A bit odd how everyone focuses only on whether or when Italian bond yields will rise 200bps. Isn’t the real problem why a 200bps move would send everything in Europe overboard in the first place?
It’s a single point of failure, no?
SPOF is usually a term applied to downtime errors on website networks. (Though in 2011 you could already have applied it to Japanese nuclear power stations, to Congressional politics, to a currency union’s correlated capital structure — it’s any situation involving incremental error bleeding into systemic collapse.)
It’s now implicit in the Italian government bond market.
There’s been one objection to the idea of a sustained permanent 200bps move in any case, which is that Italy has a big, highly liquid government bond market, where the periphery definitely doesn’t.
For instance, the HDAT Greek government bond market recorded under €700m worth of daily volumes in May 2011, compared to around €12bn worth of daily turnover in Italian government debt on the MOT bond market of Borsa Italiana. You could guess which market is more vulnerable to sudden price swings, or would have trouble finding buyers during a pronounced sell-off.
At the same time it would have just been a guess. A bad one. In realised terms, we’ve homed in straight though a 100bps move within just over a month for Italian bonds. Just look at the spread shift in July! (Hat-tip to the FT’s Richard Milne).
And what no one seems to realise yet is that even at 5 per cent, Italian yields are already unsustainable. Everything that seems beneficial to liquidity — the Italian state’s heavy refinancing of its debt — can end up consolidating higher yields into the system. It could quite easily row back to “normal” in the next few days or weeks, but then that’s the classic Fukushima error — eventually, jump risk jumps, and is enough to wipe out ten years of a quiet market. Certainly it’s hard to see the eurozone still being here in 2021 if Italy keeps getting worse.
In short, it’s classic single point of failure stuff and it connects to other examples on display in the eurozone, such as the ECB’s dependence on a few ratings agencies for its collateral framework, or the dodgy structural array of sovereign guarantees behind the EFSF. (Naturally the Treasury market offers a strong analogy at this point, and in fact the cascade will truly be catastrophic in repo and money markets come August 3.)
So the lesson is, don’t rely on bond market liquidity as your big cushion while you dispatch other problems.
The second lesson is perhaps, well, to create a truly massively liquid bond market designed to cover all points of failure. For example a centralised European Treasury, set to immediately begin issuing Eurobonds in place of national debt. It’s not like Italy would have anything else to save it in an acute crisis.
But at this rate would even a Eurobond carry an acceptable credit risk? Since that increasingly looks like the only game in town, we would like some assurance…
Related links:
True Europeans need a ‘Plan B’ – George Soros / FT A-List
Tail about to wag dog again – Bond Vigilantes
‘A new era of Treasury price volatility’ – FT Alphaville
